3 Stocks Vulnerable in a Down Market - 8359 views

MINNEAPOLIS (Stockpickr) -- The market appears to have weathered the storm. Chaos around the world created somewhat of a panic, but not enough to create capitulation. Instead, the level of fear has risen to a point that some view recent goings-on as bullish.

In general, I am bullish, but not without some real anxiety. Many of the stocks on my radar have appreciated to the point of making much of the market pricey or fully valued. It is tough to find a bargain out there.

The one variable that changes things for stocks is earnings. If companies report stronger-than-expected results, stocks are likely to reach new highs. If the results are poor, look out below. No wonder new investors are reluctant to commit capital in such an environment.

Yet anecdotally we are hearing about the return of the little guy. The entrance to the party when others are preparing to leave is a story as old as the markets. The little guy is always the last one to the party and the last one to leave. Should you be concerned?

There seems to be mixed opinions on the topic. Noted stock market guru and investor Laszlo Birinyi claims that this bull market is only half complete. His expectation is for the S&P 500 to reach 2854 by 2013. That would have the bull market lasting for another two years.

I’m not sure everyone agrees with that assessment. Recently more than half of economists, real estate experts and investment strategists polled by MacroMarkets expect home prices across the nation to double dip. Without a strong housing market, it is difficult to envision stock prices moving significantly higher from here.

Luxury home builder Toll Brothers (TOL) appears to be on the road to recovery. Shares of Toll Brothers have rebounded nicely since bottoming in 2009 thanks in part to three straight quarters of operating profits.

That said, shares of Toll trade well below post-crash highs, reflecting the extent of the damage in the home building market. Perhaps worse for Toll is stock appreciation that has resulted in the stock's being fairly pricey today. Shares trade for some 1.3 times book value. Historically homebuilding stocks are cheap when shares are priced 10% to 20% below book value.

If book value decreases as a result of operating losses or balance sheet adjustments due to falling home prices, shares of Toll Brothers may be vulnerable to a selloff. Thus far, shares have held up relatively well in 2011, but that optimism may start to crack if the homebuilding market softens.

Investors may be too optimistic with Toll Brothers. For the current quarter ending April 30, analysts are predicting a loss of 4 cents per share. This compares quite favorably with the loss of 24 cents per share in the year-ago period. When the report comes out in May, investors will be looking closely at contracts for building in future months.

If those numbers disappoint, look out below. Toll Brothers is ripe for a decline.

If the economy stumbles in coming months, one of the first dominos to fall will be the consumer. Already-strapped consumers are facing higher commodity prices and a job market that is not strong for income growth. That combination can only mean spending suffers -- and discretionary spending in particular.

One place that consumers spend money is at the movie theater. Shares of Carmike Cinemas (CKEC) spiked in early March thanks to a Wall Street upgrade and an optimistic earnings report from the company. The stock moved up by 12% despite the company's reporting a loss of 24 cents a share in the period reported and widely missing analyst estimates.

That future won’t might not be so bright if there is a double dip in housing prices. Sure, people like to attend movies as an escape from reality, but the currently reality is one of tight budgets amid rising prices. Popcorn at the theater is already expensive. What happens when they try to raise concession prices?

I’d be a bit cautious with Carmike. Small-cap stocks such as Carmike are particularly vulnerable in a downturn. If the company has marginal profits to begin with, those losses can be even more severe. I can envision short-sellers being very aggressive with their negativity around a stock such as Carmike in an environment of weaker spending.

For now Wall Street is optimistic that Carmike can make 35 cents per share in the current year ending in December. The current view is that this company has turned the corner as profits are expected to nearly double in 2012. That sounds like a good opportunity, but the risks are high.

Best Buy

I am never a big fan of a company changing its business model during economic challenges. The noise and distraction from difficult operating conditions can cloud management judgment. It is far better to stay focused with doing the things that made you successful in the first place.

Recent new from Best Buy (BBY) is troubling. The company reported earnings that were less than stellar, though not all that horrible considering falling TV sales. The company reported that net income fell to $1.62 per share for its fourth quarter. Excluding international restructuring costs, net income was $1.82 per share.

So why did the stock fall by more than 5% on Thursday? For starters, the outlook for fiscal 2012 is less than inspiring. The big box retailer is facing an onslaught of competition in a market of weak demand. Those conditions have management scrambling for a solution.

The solution announced with the report was an emphasis on opening smaller stores and focusing on more profitable, fast growing categories like smart phones and tablet computers. The move is a major change for the company and investors are rightly skeptical.

If there is a market downturn triggered by a weaker economy, the news for Best Buy is likely to get worse before it gets better. The big unknown is what a smaller-footprint business model does for the company. Will it be as profitable as its prior strategy of market dominance based on sheer size? Will the company be able to stem the tide from online competition?

There are many questions, and investors are rightly selling first before finding out the answers. The future does not look bright for Best Buy, and that will get magnified in a market downturn.

At the time of publication, author had no positions in stocks mentioned.

Jamie Dlugosch is a founder and contributor to MainStreet Investor and MainStreet Accredited Investor. Formerly, he was president and CEO of Al Frank Asset Management. He has contributed editorially to The Rational Investor, The Prudent Speculator, Penny Stock Winners and InvestorPlace Media.